Saturday, October 23, 2010

SIA Engineering – Analysis of Purchase Part 4

For Part 4 of this Analysis of Purchase, I move on to competitive analysis by comparing SIAEC to competitors within the same MRO industry. One is from Singapore (ST Aerospace, a division of ST Engineering Limited, listed on the Stock Exchange of Singapore), another is from Hong Kong (Hong Kong Aircraft Engineering Company or HAECO, listed on HKSE); and the last one is from Canada (Vector Aerospace Corporation, listed on Toronto Stock Exchange). I will not be doing an analysis which is as comprehensive as the one I am doing for SIAEC, and will merely be focusing on the financial aspects and comparing them to SIAEC; as well as offering comments on the Balance Sheets and Cash Flows, where applicable.

Hong Kong Aircraft Engineering Company (HAECO)

HAECO is a subsidiary of Swire Pacific Group of companies and has provided comprehensive aeronautical engineering and maintenance services to airlines and operators since 1950. Its website is at and gives a good introduction of the company’s business activities. They basically also do heavy maintenance, technical inspections and line maintenance for their customers and their activities are very similar to SIAEC. Their financial year-end is December 31.

It is fairly interesting to note that for HAECO, their revenue base has grown quite considerably over the years as compared to SIAEC, mainly due to the different nature of expansion for the two companies. For SIAEC, as mentioned, they go through JV and M&A and so their revenue base from consolidation does not increase so much. For HAECO, their average 10-year operating margin is 13.7%, quite comparable with SIAEC’s operating margin of 13.9%. Average ten-year net profit margin for HAECO is 20.2% against 23.1% for SIAEC, which shows that SIAEC has a slightly better net profit margin as compared to HAECO. Even in terms of current ratio, SIAEC has a higher average of 2.49 compared with HAECO’s average of 1.89; and this is because HAECO’s current ratio has deteriorated somewhat from FY 2006 to FY 2009 to below 2.0 (before FY 2006 it was consistently above 2.0). Average 10-year ROE for HAECO was also lower as compared to SIAEC’s 10-year average, at 16.9% against 22.5%. In addition, it seems HAECO started taking on a little more debt towards FY 2008-FY 2009 period, as debt had hit HK$1.126 billion for FY 2009 and the Group had a debt:equity ratio of 0.22. SIAEC, on the other hand, remained debt-free during all ten years in the analysis.

Looking at HAECO’s cash flows (only 8 years were used as FY 2001’s Annual Report was not available for download on the Company’s website), it can be seen that there was also FCF generated every financial year, similar to SIAEC. However, unlike SIAEC, investing cash flows have been mostly negative (for the last 5 years out of the 8 years under review); and capex is also pretty high as a % of revenues as it more recently (in the last 5 years) averaged about 17.6%. On the other hand, SIAEC’s capex averaged just 5% of revenues for the ten years under review, which demonstrates the robustness of SIAEC’s strategy of using alliances and joint ventures to reduce capex commitments for the Group. Notice too that HAECO paid out a special dividend in FY 2002 and FY 2003 (when investing cash flows were positive); and just once more in FY 2006.

Singapore Technologies Aerospace (ST Aerospace)

ST Aerospace is the MRO arm of ST Engineering, a Singapore-listed conglomerate which has many diverse divisions dealing with electronics, land systems and marine facilities. The division is one of the largest third-party, independent aviation repair and overhaul (MRO) companies in the world. Our global customer base includes many of the world's advanced air forces, leading airlines and air freight operators. ST Aerospace provides defence and commercial customers a total aviation support system, having extensive capabilities in engineering and development, life cycle maintenance, materials and component supplies, refurbishment, customised modifications and upgrades. Website and information can be found at The information below was compiled from ST Engineering’s Annual Reports from FY 2000 through to FY 2009.

Interestingly, a quick comparison of SIAEC with ST Aerospace (STAE) shows that STAE actually has higher revenues than SIAEC, at S$1.875 billion versus SIAEC’s FY 2010 revenue of S$1 billion. STAE’s revenues had also roughly doubled in the last ten years since FY 2000, while for SIAEC its revenues had increased by merely 52% from FY 2001 through to FY 2010. In fact, operating margin for STAE was also better than SIAEC, at 16.5% on average compared to SIAEC’s average of 13.9%. Considering STAE is just one division of ST Engineering, such results are very impressive indeed as they indicate the division is very well-managed; but the problem is in seeing the “big picture” of the aerospace division being just one of four divisions at ST Engineering (i.e. you could not buy shares of STAE by itself; even if it was evaluated to be a much better business than SIAEC). But more on that later……

The positives for STAE continue on with very high ROE of 47.4% on average! This is because it has a pretty low equity base, but it makes me wonder if this is because STAE is only a division of ST Engineering and so its equity may be consolidated into the Group’s books; hence I am not sure how much reliance I can place on this super-high ROE. But on the surface, it certainly looks attractive, and from an Income Statement standpoint STAE’s financials look more impressive than SIAEC.

From a Balance Sheet standpoint, however, the story is a little different. Looking at current assets versus current liabilities, STAE had some years where they had negative working capital and current ratio of less than one. As a result, its average current ratio was just 1.13 over ten years; against 2.49 for SIAEC (which has never had a year of negative working capital). Looking at debt, it seems STAE’s debt had steadily increased over the years, starting from just S$19 million in FY 2000 to S$360 million as at FY 2009; for a debt to equity ratio of 0.87 as at December 31, 2009. STAE was also in net debt for FY 2008 and FY 2009, as loans exceeded cash and bank balances. SIAEC, on the other hand, maintained zero gearing and always had excess cash in the bank; so in terms of Balance Sheet strength I would conclude SIAEC is stronger on this aspect.

As we turn to cash flows, STAE shows good operating cash inflows and there is also FCF generated every year except for FY 2008. Capex spending as a proportion of revenues was also low at 5.6%, comparable to SIAEC’s 5.0%. Of course, net investing cash flows for STAE are not as strong as SIAEC, but this is due to the nature of SIAEC’s business of having associated companies and joint ventures, which from STAE’s books are not very significant. Still, to be fair and objective, STAE does have robust cash flows which are in every way comparable to SIAEC’s.

So in conclusion, I would say STAE would make a pretty good investment itself; assuming one could determine the dividend flows (they are not separately “tagged” to STAE and are declared on a group basis from ST Engineering) and if STAE traded separately under its own counter name. But the gearing issue does bother me and I would be wary of the business as it sometimes has negative working capital and also carries net debt.

Vector Aerospace Corporation

Vector Aerospace Corporation (“Vector”) is a Canadian Company founded in 1998 and is a global provider of aviation maintenance, repair and overhaul services for fixed and rotary-wing aircraft. Vector provides services to commercial and military customers for various types of gas turbine engines, helicopter dynamic components and helicopter airframes. It has customers spanning Canada, North America, Europe and Africa. It is listed on the Toronto Stock Exchange under the stock symbol “RNO”. Its website is located at All numbers and information were obtained from Vector’s Annual Reports from 2000 through to 2009.

Looking at Vector’s 10-year financials, it seems that the Company had a chequered past during the 2001-2003 period as it suffered from operating and net losses; and it was only after FY 2005 that the business began to pick up and profits were more consistent. The few years of losses seem to coincide with the bear market of 2000 to 2002, and could be the reason for this under-performance. Operating margins are not high either, at an average of just 8.5% over eight years (excluding negative margins); while net profit margin was just 4.4% over 7 years.

Working capital was healthier than that of STAE, as every year registered positive working capital and ten-year average current ratio was 1.54 (STAE had an average of 1.13; SIAEC’s was 2.49). However, debt was quite a significant portion of Vector’s Balance Sheet, though this was gradually being reduced all the way till FY 2010. Debt:Equity ratio peaked at 2.46 in FY 2003 and gradually decreased till 0.30 in FY 2009, but the fact remains that debt is a very persistent aspect of Vector’s Balance Sheet, and even though they generate decent FCF, they still have reliance on debt to grow the business. ROE was full of ups and downs, dipping to negative 10.6% during the worst year (FY 2001) to as high as 17.5% in FY 2008; but never in any one year did it exceed 20%. Average ROE for all 7-years (in which there was +ve ROE) was just 13.2%; and when all ten years were taken into account the average ROE was a mere 0.5%! This is in contrast to SIAEC’s much more consistent ROE over the years; averaging 22.5% over ten years.

In terms of cash flows, something which struck me as being very strange was how cash at bank always squared off to zero at the end of each financial year from FY 2000 through to FY 2007; as bank loans raised, government grants obtained and funds raised always cancelled out the spending and cash outflows. Perhaps there is some law I am unaware of, or something about Vector which enables it to rely on some grant income or subsidies for X number of years. Thus, in this case, cash flows for Vector are not very comparable, except for the capex section. Spending on capex as a proportion of revenues was very low for Vector, in fact even lower than SIAEC on average, but note that there was negative FCF for three out of ten financial years.

To conclude, Vector’s case is somewhat not directly comparable to SIAEC due to the nature of cash flow statement as mentioned above, and also because of very different tax laws and possibly accounting systems for Canada versus Singapore. Still, it acts as a good competitive comparison.

Competitive Analysis Summary

The three competitors chosen in this section represent some of the dominant players in the MRO industry; and though some of them have features which are stronger than SIAEC; I would think that as a package, SIAEC boasts the most consistent (and growing) profitability, is unleveraged and has very strong FCF.

Valuations are admittedly not cheap for SIAEC (about 15x historical currently, close to its 5-year average PER valuation), and is about 13.9x ex-cash of 53 cents/share. However, I do believe in buying a good company at a fair price, rather than a mediocre company at a good price. I am also willing to count on the continuity of the dividend yield to act as a cushion against long-term capital loss should the business show signs of permanent deterioration.

In the last and final Part 5 of this Analysis of Purchase, I shall touch on the Global MRO industry outlook (and comment a little on the Middle East too), as well as talk about SIAEC’s prospects (based on FY 2010’s Annual Report), do a pros and cons analysis; and conclude.


Ding sheng said...

nice work:) sometimes a subsidiary can be afford to be more leveraged because they have the backing of the parent company:)

anyway do u go through each company 10 year annual reports to get the financial statements? if so, it must be pretty hard work.

Musicwhiz said...

Hello Ding Sheng,

Thanks for visiting and commenting. Yes, I do agree that subsidiaries can afford to be heavily leveraged if the parent can lend their financial support. There are cases where associated companies are highly geared (like 2.5x gearing) while receiving "support" from the parent. That case is Ezra and 47.9% owned EOC Limited (listed on Oslo Bors).

Yes I did go through every company's annual report, but usually they have a 5-year summary so I pick most of the numbers from there. For other numbers, you'd have to painstakingly go through the Balance Sheet/Cash Flow Statement year by year.

Haha, no one said investing was easy! In fact, it's tedious and requires a lot of reading and research.


Ding sheng said...

lol. i love your blog. Definitely one of the more readable ones online. At least our investment philosophies align pretty well.

Well, going through the annual reports is pretty much what I do too to get historical figures:) gives up to past 4 years figures for most important figures though. You might wanna check it out:)

Musicwhiz said...

Hi Ding Sheng,

Thanks! Glad to know we have similar investment philosophies.

Thanks for the link too, will check it out.